Treasury Advisory

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2009 2nd Annual Public Interest Meeting

• Treasury Advisory
• Committee on the
• Auditing Profession - ACAP

• Lynn Turner
• Member of ACAP

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ACAP Committee Members

• Arthur Levitt, Co-Chair
• Don Nicolaisen, Co-Chair
• Alan Beller, Partner Cleary Gottlieb
• Amy Brinkley, Global Risk Executive BofA
• Mary Bush, Board Member Briggs Stratton,
  Discover Financial, ManTech, United Airlines
• Rodgin Cohen, Chairman Sullivan Cromwell
• Tim Flynn, CEO KPMG
• Bob Glauber, Board Member Moodys, Freddie Mac,
  XL Capital, Quadra Realty
• Ken Goldman, CFO Fortinet
• Gaylen Hansen, EKSH NASBA
• Barry Melancon, CEO AICPA
• Anne Mulcahy, Chairman CEO Xerox
• Rick Murray, Managing Director Swiss Re
• Gary Previts, President AAA Case Western
• Damon Silvers, Associate General Counsel AFL-CIO
• Richard Simonson, Executive VP CFO Nokia
• Sarah Smith, Controller CAO Goldman Sachs
• Bill Travis, Former Managing Partner McGladrey
• Lynn Turner, Former SEC Chief Accountant

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ACAPCharge

• The Treasury Department established the Advisory
  Committee on the Auditing Profession to examine
  the sustainability of a strong and vibrant
  auditing profession.  The Committee will
  consider, among other things, the auditing
  professions ability to cultivate, attract, and
  retain the human capital necessary to meet
  developments in the business and financial
  reporting environment and ensure audit quality
  for investors audit market competition and
  concentration and the impact of the independence
  and other professional standards on this market
  and investor confidence and the organizational
  structure, financial resources, and communication
  of the auditing profession. 

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ACAPBackground on Public Process

• Announced May 2007, Commenced October 2008,
  Report Approved Sept. 26, 2008
• 8 public meetings, 6 face to face.
• Testimony from 57 witnesses
• Numerous subcommittee meetings
• Testimony from witnesses
• Four releases in Federal Register
• Two exposure drafts
• 101 public comment letters

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ACAP Issues Discussed

• Education
• Liability Reform
• Usefulness of Audit Report
• Audit Firm Transparency
• Key Performance Indicators of Audit Quality
• Auditor Independence
• Fraud Responsibility
• Firm Governance
• Barriers to Smaller Firms
• Mobility of CPA Practice / National Licensure
• State Regulatory Regime

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ACAPNotable Recommendations

• Update College Curricula, Textbooks CPA Exam
• Increase Funding for Qualified Accounting Faculty
• National Center to Detect Prevent Fraud
• State Federal Regulatory Cooperation
• Consolidate Independence Standards
• Mechanism to Prevent Loss of Large Firm
• Report Reasons for All Auditor Changes
• Independent Firm Board Members
• Key Performance Indicators of Audit Quality
• Reduce Barriers to Small Firms
• Partner Signature on Audit Reports
• Revise Standard Audit Report

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ACAPHuman Capital Recommendations

• Recommendation 1. Implement market-driven,
  dynamic curricula and content for accounting
  students that continuously evolve to meet the
  needs of the auditing profession and help prepare
  new entrants to the profession to perform high
  quality audits.
•  (a) Regularly update the accounting
  certification examinations to reflect changes in
  the accounting profession, its relevant
  professional and ethical standards, and the
  skills and knowledge required to serve
  increasingly global capital markets.
• (b) Reflect real world changes in the business
  environment more rapidly in teaching materials.
• (c) Require that schools build into accounting
  curricula current market developments.

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ACAPHuman Capital Recommendations

• Recommendation 2. Improve the representation and
  retention of minorities in the auditing
  profession so as to enrich the pool of human
  capital in the profession.
• (a) Recruit minorities into the auditing
  profession from other disciplines and careers.
• (b) Institute initiatives to increase the
  retention of minorities in the profession.
• (c) Emphasize the role of community colleges in
  the recruitment of minorities into the auditing
  profession.
• (d) Emphasize the utility and effectiveness of
  cross-sabbaticals and internships with faculty
  and students at Historically Black Colleges and
  Universities.
• (e) Increase the numbers of minority accounting
  doctorates through focused efforts.

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ACAPHuman Capital Recommendations

• Recommendation 3. Ensure a sufficiently robust
  supply of qualified accounting facultyto meet
  demand for the future and help prepare new
  entrants to the profession to performhigh quality
  audits.
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• (a) Increase the supply of accounting faculty
  through public and private funding and raise the
  number of professionally qualified faculty that
  teach on campuses.
• (b) Emphasize the utility and effectiveness of
  cross-sabbaticals.
• (c) Create a variety of tangible and sufficiently
  attractive incentives that will motivate private
  sector institutions to fund both accounting
  faculty and faculty research, to provide practice
  materials for academic research and for
  participation of professionals in behavioral and
  field study projects, and to encourage practicing
  accountants to pursue careers as academically and
  professionally qualified faculty.

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ACAPHuman Capital Recommendations

• Recommendation 4. Develop and maintain consistent
  demographic and higher educationprogram profile
  data. 
• Recommendation 5. Encourage the AICPA and the AAA
  jointly to form a commission to provide a timely
  study of the possible future structure of higher
  education for the accounting profession.

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ACAPFirm Structure and Finances

• Recommendation 1. Urge the creation by the Public
  Company Accounting Oversight Board (PCAOB) of a
  national center to facilitate auditing firms and
  other market participants sharing of fraud
  prevention and detection experiences, practices,
  and data and innovation in fraud prevention and
  detection methodologies and technologies, and
  commission research and other fact-finding
  regarding fraud prevention and detection, and
  further, the development of best practices
  regarding fraud prevention and detection.
• - PCAOB to review Fraud standard

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ACAPFirm Structure and Finances

• Recommendation 2. Encourage greater regulatory
  cooperation and oversight of the public company
  auditing profession to improve the quality of the
  audit process and enhance confidence in the
  auditing profession and financial reporting.
• (a) Institute the following mechanism to
  encourage the states to substantially adopt the
  mobility provisions of the Uniform Accountancy
  Act, Fifth Edition (UAA) If states have failed
  to adopt the mobility provisions of the UAA by
  December 31, 2010, Congress should pass a federal
  provision requiring those states to adopt these
  provisions.
• (b) Require regular and formal roundtable
  meetings of regulators and other governmental
  enforcement.
• (c) Urge the states to create greater financial
  and operational independence of their state
  boards of accountancy.

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ACAPFirm Structure and Finances

• Recommendation 3. Urge the PCAOB and the SEC, in
  consultation with other federal and state
  regulators, auditing firms, investors, other
  financial statement users, and public companies,
  to analyze, explore, and enable, as appropriate,
  the possibility and feasibility of firms
  appointing independent members with full voting
  power to firm boards and/or advisory boards with
  meaningful governance responsibilities to improve
  governance and transparency of auditing firms.
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• Recommendation 4. Urge the SEC to amend Form 8-K
  disclosure requirements to characterize
  appropriately and report every public company
  auditor change and to require auditing firms to
  notify the PCAOB of any premature engagement
  partner changes on public company audit clients.

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ACAPFirm Structure and Finances

• Recommendation 5. Urge the PCAOB to undertake a
  standard-setting initiative to consider
  improvements to the auditors standard reporting
  model. Further, urge that the PCAOB and the SEC
  clarify in the auditors report the auditors
  role in detecting fraud under current auditing
  standards and further that the PCAOB periodically
  review and update these standards.
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• Recommendation 6. Urge the PCAOB to undertake a
  standard-setting initiative to consider mandating
  the engagement partners signature on the
  auditors report.

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ACAPFirm Structure and Finances

• Recommendation 7. Urge the PCAOB to require that,
  beginning in 2010, larger auditing firms produce
  a public annual report incorporating (a)
  information required by the EUs Eighth
  Directivedeemed appropriate by the PCAOB, and
  (b) such key indicators of audit quality and
  effectiveness as determined by the PCAOB .
  Further, urge the PCAOB to require that,
  beginning in 2011, the larger auditing firms file
  with the PCAOB on a confidential basis audited
  financial statements.
• Several Committee members supported public
  financial statements

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ACAPConcentration and Competition

• Recommendation 1. Reduce barriers to the growth
  of smaller auditing firms consistent with an
  overall policy goal of promoting audit quality.
  Because smaller auditing firms are likely to
  become significant competitors in the market for
  larger company audits only in the long term, the
  Committee recognizes that Recommendation 2 will
  be a higher priority in the near term.
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• (a) Require disclosure by public companies in
  their registration statements, annual reports,
  and proxy statements of any provisions in
  agreements with third parties that limit auditor
  choice.
• (b) Include representatives of smaller auditing
  firms in committees, public forums, fellowships,
  and other engagements.

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ACAPConcentration and Competition

• Recommendation 2. Monitor potential sources of
  catastrophic risk faced by public company
  auditing firms and create a mechanism for the
  preservation and rehabilitation of troubled
  larger public company auditing firms.
• (a) As part of its current oversight over
  registered auditing firms, the PCAOB should
  monitor potential sources of catastrophic risk
  which would threaten audit quality.
• (b) Establish a mechanism to assist in the
  preservation and rehabilitation of a troubled
  larger auditing firm. A first step would
  encourage larger auditing firms to adopt
  voluntarily a contingent streamlined internal
  governance mechanism that could be triggered in
  the event of threatening circumstances. If the
  governance mechanism failed to stabilize the
  firm, a second step would permit the SEC to
  appoint a court-approved trustee to seek to
  preserve and rehabilitate the firm.

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ACAPConcentration and Competition

• Recommendation 3. Recommend the PCAOB, in
  consultation with auditors, investors, public
  companies, audit committees, boards of directors,
  academics, and others, determine the feasibility
  of developing key indicators of audit quality and
  effectiveness and requiring auditing firms to
  publicly disclose these indicators. Assuming
  development and disclosure of indicators of audit
  quality are feasible, require the PCAOB to
  monitor these indicators.

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ACAPConcentration and Competition

• Recommendation 4. Promote the understanding of
  and compliance with auditor independence
  requirements among auditors, investors, public
  companies, audit committees, and boards of
  directors, in order to enhance investor
  confidence in the quality of audit processes and
  audits.
• - Does NOT recommend a rewrite of the rules.

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ACAPConcentration and Competition

• Recommendation 5. Adopt annual shareholder
  ratification of public company auditors by all
  public companies.
• Recommendation 6. Enhance regulatory
  collaboration and coordination between the PCAOB
  and its foreign counterparts, consistent with the
  PCAOB mission of promoting quality audits of
  public companies in the United States.

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ACAPLitigation

• Issue of Investors vs. Auditing Profession
• Auditors
• Want federalization of all litigation
• Liability caps not pushed for
• Disagreement among firms at CAQ
• Limits on appeal bonds
• Ability to appeal on motions to dismiss
• Pleading standard of Fraud Scienter SEC
  Rule 10(b)(5)

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ACAPLitigation

• Investors
• Did not favor tradeoffs
• Want right to state courts
• Want clear pleading standard
• Rule 102(e)
• With respect to persons licensed to practice as
  accountants, "improper professional conduct"
  under
• 201.102(e)(1)(ii) means
• (A) Intentional or knowing conduct, including
  reckless conduct, that results in a violation of
  applicable professional standards or
• (B) Either of the following two types of
  negligent conduct
• (1) A single instance of highly unreasonable
  conduct that results in a violation of applicable
  professional standards in circumstances
  in which an accountant knows, or should know,
  that heightened scrutiny is warranted.
• (2) Repeated instances of unreasonable conduct,
  each resulting in a violation of applicable
  professional standards, that indicate a lack of
  competence to practice before the
  Commission.

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ACAPLitigation

• Report Highlights Chasm between Investors and
  Auditors.
• Investors opposition in comment letters was
  universal.
• Deeper distrust as a result of process.
• Process documented 2 views of each side.
• Dont expect change in forseeable future.

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ACAPArguments for Litigation Changes

• Catastrophic Litigation Threat Supported by Data
• Insurance Difficult to Get or Unavailable
• Auditor Potentially Liable for Entire Drop in
  Market Cap
• Increase average equity of 1.375 B in 1997 to
  3.842 B in 2007
• Claims can be significant multiple of firm
  capital
• Difficulty to Bring Large Cases to Trial
• Can Cases be Settled for Reasonable Amounts in
  Future?
• Threat Doesnt Improve Audits
• Threat Leads to Over-Auditing / Increase Costs

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ACAPArguments For Litigation

• Sustainability Rests With Firm Conduct Tone
• Risk of Loss Overstated Based on Data
• Claims irrelevant e.g. 1996-2007
  settlements/claims 4.8
• 2008 GAO Report
• If risk of litigation further minimized audit
  intensity will decrease
• Difficulty Obtaining Insurance Not Unique to
  Audit Firms
• Right to Sue Important Motivator to Hold Firms
  Accountable to Investing Public
• Recent Supreme Court Cases Raise Bar to Recover
  Losses
• Dura Pharmaceuticals and Tellabs